CFA Fixed Income - CFA Smart Tips To Pass Your Level 1 Exam

This training is extremely different from the other programs and has been battle tested by thousands of CFA Candidates.

No matter where you stand in your preparation this program is powerful and will give you the confidence and the elements you are missing.

The program has been designed to make complicated concepts easy. It is especially intended for those who have difficulties going through the material alone.

Whatever the material you like and picked for your preparation, this program will help you take the most out of your investment and time spent actually studying.

Investing in this training is like getting a personal one-on-one helicopter ride to the top of the mountain. You don't have to climb it yourself.

In this lecture, you are going to learn that:

- Fixed income is a major asset class and it is one of the Big 5 areas for the CFA Level 1 Exam.

- It carries a weight of between 10% to 12% for the CFA level 1 exam i.e. Similar weightage as of the topic area Equity Investments.

- In this course, we are going to focus on more technical (analytical) concepts.

- Please remember that according to the post-exam surveys from the CFA exam candidates, Fixed Income has been rated as one of the most challenging areas for the CFA level 1 exam for the past many years. But don’t worry, we are going to start from the very basics and assume that you absolutely know nothing.

The lecture discusses the defining elements of fixed-income security which include the following:

1. Issuers of Bonds

2. Bond Maturity

3. Par Value

4. Coupon Payments

5. Yield to Maturity

The value of a coupon bond can be calculated by summing the present values of all of the bond’s promised cash  flows. The market discount rate appropriate for discounting a bond’s cashflows is called the bond’s yield-to-maturity (YTM). If we know a bond’s yield-to-maturity, we can calculate its value. Learn more about this concept in this lecture.

You will learn the following concepts from this lecture:

1. Yield to Maturity (YTM) is the discount rate that makes the present value of a bond’s cashflows equal to its price.

2. If a bond’s coupon rate is greater than its YTM, its price will be at a premium to par value. If a bond’s coupon rate is less than its YTM, its price will be at a discount to par value.

The percentage decrease in value when the YTM increases by a given amount is smaller than the increase in value when the YTM decreases by the same amount (the price-yield relationship is convex). Learn this concept with an example i.e., mathematically in this lecture.

Arguably, the most important graph from the fixed-income securities section is the Price-Yield Curve. This lecture graphically discusses the inverse relationship between the market price of a bond with its yield using the Price-Yield Curve. Learn the key concepts of Fixed Income Securities topic area in this lecture.

Throughout this course we will celebrate your progress at 25%, 50%, 75% and 100%. I really want you to succeed but you need to take action and keep going so look forward to these milestones of progress. I will see you there and cheer you on as you keep going from one milestone to the next >>

A Yield Curve shows yields by maturity. The term structure of interest rates refers to the yields at different maturities (terms) for like securities or interest rates.

Interest rate risk is the risk that arises for bondholders from fluctuating interest rates. How much interest rate risk a bond has depends on how sensitive its price is to interest rate changes in the market. Duration is used as a measure of a bond’s interest rate risk. There are three different ways of calculating duration:

1. Macauley Duration

2. Modified Duration

3. Effective Duration

A bond’s Macaulay Duration is calculated as the weighted average of the number of years until each of the bond’s promised cash lows is to be paid, where the weights are the present values of each cash low as a percentage of the bond’s full value.

The difference between a bond’s Macaulay duration and the bondholder’s investment horizon is referred to as a duration gap. A positive duration gap (Macaulay duration greater than the investment horizon) exposes the investor to market price risk from increasing interest rates. A negative duration gap (Macaulay duration less than the investment horizon) exposes the investor to reinvestment risk from decreasing interest rates.

Before we start discussing the other two measures of duration, let's first have a recap of the main topics we have covered so far. These include:

• Bond Valuation

• Price-Yield Curve

• Macauley Duration

• Convexity

This lecture is a recap of the Duration Gap Concept. Remember, the difference between a bond’s Macaulay duration and the bondholder’s investment horizon is referred to as a duration gap. A positive duration gap (Macaulay duration greater than the investment horizon) exposes the investor to market price risk from increasing interest rates. A negative duration gap (Macaulay duration less than the investment horizon) exposes the investor to reinvestment risk from decreasing interest rates.

Modified Duration provides an approximate percentage change in a bond’s price for a 1% change in yield to maturity. The first method of calculating Modified duration is to divide Macaulay duration (MacDur) by one plus the bond’s Yield To Maturity (YTM).

The second method of calculating modified duration directly uses bond values for an increase in YTM and for a decrease in YTM of the same size. The calculation of approximate modified duration is based on a given change in YTM. V– is the price of the bond if YTM is decreased by ΔYTM and V+ is the price of the bond if the YTM is increased by ΔYTM. Note that V– > V+. Because of the convexity of the price-yield relationship, the price increase (to V–), for a given decrease in yield, is larger than the price decrease (to V+).

Before we start discussing the third measure of duration i.e., Effective Duration, let's first have a recap of the first two measures of duration:

1. Macauley Duration

2. Modified Duration (Both Methods of Calculating it)

The pricing of bonds with embedded put, call, or prepayment options begins with the benchmark yield curve, not simply the current YTM of the bond. The appropriate measure of interest rate sensitivity for these bonds is the Effective Duration.

Spot Rates are market discount rates for single payments to be made in the future. The discount rates for zero-coupon treasury bonds are spot rates and we sometimes refer to spot rates as zero-coupon rates or simply zero rates. Instead of using YTM as a discount rate to value bonds, we have to use spot rates to value them if the yield curve is not flat.

Throughout this course we will celebrate your progress at 25%, 50%, 75% and 100%. I really want you to succeed but you need to take action and keep going so look forward to these milestones of progress. I will see you there and cheer you on as you keep going from one milestone to the next >>

The yield-to-maturity is calculated as if the discount rate for every bond cash flow is the same. That is only possible if the term structure of interest rates is flat. In reality, discount rates depend on the time period in which the bond payment will be made. Watch this lecture and understand the difference between the YTM and the Spot Rates.

The main limitation of the modified duration measure is that it is a linear estimate of the relation between a bond’s price and YTM, whereas the actual relation is convex, not linear. This means that the modified duration measure provides good estimates of bond prices for small changes in yield only, but inaccurate estimates for larger changes in yield as the effect of the curvature of the price-yield curve is more dominant.

A Forward Rate is a borrowing/lending rate for a loan to be made at some future date. The notation used must identify both the length of the lending/borrowing period and when in the future the money will be loaned/borrowed. Thus, 1y1y is the rate for a 1-year loan one year from now; 2y1y is the rate for a 1-year loan to be made two years from now; and so on.

The idea here is that borrowing for two years at the 2-year spot rate, or borrowing for one-year periods in two successive years, should have the same cost.

We can use spot rates to calculate short-term forward rates as seen in the previous lecture. Here in this lecture, we will show you a very interesting and easy method of calculating forward rates using spot rates. We call it "The Lego Block Method". The lego method is explained using an example. Watch and learn :)

This is in continuation of the previous lecture. We will be using another example to demonstrate to use of the Lego Method.

A Contingency Provision in a contract describes an action that may be taken if an event (the contingency) actually occurs. Contingency provisions in bond indentures are referred to as Embedded Options, embedded in the sense that they are an integral part of the bond contract and are not a separate security. Some embedded options are exercisable at the option of the issuer of the bond and, therefore, are valuable to the issuer (Callable Bonds); others are exercisable at the option of the purchaser of the bond and, thus, have value to the bondholder (Puttable Bonds & Convertible Bonds).

Watch this lecture to understand how these embedded options affect a bond:

1. Price

2. Yield

3. Z-Spread

4. Beneficial for the Issuer or the holder of the bond

Let's discuss two more embedded options i.e., Interest Rate Floor and Cap. Watch this lecture to understand how these embedded options affect a bond:

1. Price

2. Yield

3. Z-Spread

4. Beneficial for the Issuer or the holder of the bond

Also, understand the concept of Z-Spread.

Option-Adjusted Spread (OAS) is used for bonds with embedded options. The option-adjusted spread takes the option yield component out of the Z-Spread; the OAS is the spread to the government spot rate curve that the bond would have if it were option-free.

While the convexity of any option-free bond is positive, the convexity of a callable bond can be negative at low yields. This is because at low yields the call option becomes more valuable and the call price puts an effective limit on increases in bond value.

A Putable Bond has greater convexity than an otherwise identical option-free bond. At higher yields, the put becomes more valuable so that the value of the putable bond falls less than that of an option-free bond as yield increases. Since the value of the putable bond falls less, it has a lower duration.

High Duration Bonds have three L's (3L) :

1. Longer Maturity

2. Lower coupon

3. Lower yield

Throughout this course we will celebrate your progress at 25%, 50%, 75% and 100%. I really want you to succeed but you need to take action and keep going so look forward to these milestones of progress. I will see you there and cheer you on as you keep going from one milestone to the next >>